Thursday 6 February 2020

Going a bit 'risk off''

I'm generally a 'risk tolerant' investor, so have our SMSF money invested in the Vanguard 'High Growth' diversified Index fund, and have some margin loans (funded with a home equity loan) that are invested in ETF funds and some CFS geared equity funds (so, using home equity to fund a margin loan to fund a geared share fund is what would sometimes be termed 'triple geared' !).

Anyhow, an opinion piece in today's SMH about the immediate impact of the nCoV outbreak on China's industry (basically it's shut down until 14 Feb) and longer term outlook (the WHO daily SITREPs on nCoV cases doesn't show any major reduction in the rate of reported spread, and there may be under-reporting issues in Indonesia, and in the Chinese figures themselves) for a prolonged impact on Chinese GDP and therefore global trade and GDP, highlighted to me that aside from being a major health concern, the nCoV pandemic exposes the Chinese and global economies to increased risk. Far from Chinese industry getting 'back to normal' after 14 Feb, the continued increase in nCoV cases suggests that either a) the 'shut down' will be extended, having a major impact on economic expectations and hence share markets, or b) factories re-open as planned, but the spread of nCoV will therefore be harder to control and may have a significant long-term impact on Chinese economic performance and hence the equity markets.

Overall, there seems to be considerable down-side risk and no up-side potential (aside from health stocks such as CSL). Therefore I decided to 'rebalance' my portfolio by reallocating our SMSF from the High Growth option to a mix of Conservative (70%) and Bond (30%) options, and by selling off my geared share fund investments (and use the proceeds to pay off my margin loans and reduce my home equity loan balance). I monitor how things go over the next 3-12 months to decide when to increase my equity weighting again.

Although this will result in some capital gains tax liability, I've learned from the GFC that when its time to reduce investment risk, taxation issues should not be the tail that wags the dog.

Time will tell if this was a prudent investment decision, or an overreaction.

Being invested in 'cash' might also provide an opportunity to make some undeducted contributions into my superannuation, before my total super balance hit the 'cap'.

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Bigchrisb said...

Ballsy move!
What is the net change in your asset allocation?
From what I can see, you have shifted your super from 90% growth to about 20% growth, on about $1.2m - a reduction of about $840k of growth assets. And I'm guessing a few hundred k from the changes to the geared fund (when looking at underlying exposure).
I'm guessing that takes you to mostly Sydney residential real estate, cash/bonds and a bit of residential debt?

I've been letting my gearing wind down (currently sitting at around 15%, historically above 50%), but am still mostly invested in equities. said...

Yeah, well with the ASX200 accumulation index up about 15% over the past 12 months, and the Vanguard High Growth fund performance for the past 12 months being 22.72%, I'd rather lock in current valuations than 'bet the house' on the 'bull run' continuing for the rest of 2020. Of course if the markets continue to rise it will then be very hard to decide when to get back into equities (at an even higher level), so I could end up sitting in 'conservative' asset allocation for longer than I expect.

And if there is a large market sell-off then there will also be the problem of knowing when to 'pick the bottom' - but I'll be happy to get back into growth assets at a 25% discount of current levels even if they then continued to decline a bit more.

I'm generally an advocate of simply buying growth assets and holding for the long term, rather than trying to 'time the market', so I might end up looking like a goose. But having had index put options in place in mid 2007 and then didn't replace them when they expired in Dec 2007, I'd rather take definitive action now and live with the consequences that be looking back in 12 months and thinking "if only I'd acted when I thought the markets looked over-valued and the potential for the corona virus to impact the Chinese and global economy became obvious" ;)

ps. I've really no idea of exactly what my old and new asset allocations were/are - if you have an ungeared portfolio it is easy to say you are "5% cash, 15% bonds, 40% equities, 40% real estate" or whatever. But when you have a mortgage and also margin loans, it gets a bit weird. You can look at the total asset allocation (ignoring the debts), but the loans should really be counted as negative cash -- which results in asset allocations in relation to net portfolio value such as -40% cash, 50% equities, 30% bonds, 60% real estate. It adds up to 100% (so mathematically correct) but makes changes in asset allocation when you deleverage a bit hard to compare to normal changes in asset allocations... said...

ps. I haven't actually switched our SMSF Vanguard investments yet - unlike in the US, Vanguard Australia doesn't offer online switching, so you have to fill in a form and then either POST it or FAX it!! I got DW to sign the transfer form for our SMSF yesterday, but I'll have to POST it tonight (my workplace no longer has a fax machine) -- so the switch probably be processed until next Tuesday or Wednesday. I'll be quite annoyed if the unit price drops 5% in the meantime...

Bigchrisb said...

Well, hindsight is making your timing look petty good! How will you decide when to get back in? said...

@ Bigchrisb - I doubt that this will be a case of a short, sharp correction followed by a resumption of the bull market, so I won't be in any rush to tilt back into growth/risk asset allocation. There may be some good days when bargain hunters pile in, but I'd be suspicious that any significant rises may well turn out to be a 'dead cat bounce'. The old saying "don't try to catch a falling knife" seems relevant.

I'll keep an eye on the news, and my inclination to get back into the market will depend on how bad things get (rate of spread, global case numbers, and estimated fatality rate as reported in the WHO SITREPs), and how soon things seem to be stabilizing (either the spread is constrained, herd immunity builds up (when enough people have had COVID-19 and recovered), or when a vaccine is eventually developed AND is rolled out) - I'd guess that we'll know by late March how containment is working out (eg. if China has a rebound in case numbers once the 'back to work' edict on 15 Feb is surpassed by the incubation period of 14+ days - any rise in the China daily case increment starting next week would be a worry. And global cases currently still look like an exponential rate of increase, which is *very bad*), and we'll know by the end of this year how overall herd immunity is developing, but we probably won't see any real progress towards a vaccine until early 2021 (I'm sure there will be lots of *breakthrough* announcements, but that will be more to do with unis seeking research funding than progress towards human trials of a vaccine).

So, overall, I *might* think about getting back in in 3-6 months time if a) the market has recovered and it all turns out to have been a panic attack/dip, or b) the market has stabilised but is down 20%+ from the recent highs, and things start to look relatively under control, and the economic impacts seem to be well understood/priced in -- buying back in at a 20% discount would be a pretty good result.

But, if things still look dodgy in 3-6 months time, or the economic impacts are still in the process of 'washing through', then I'll probably wait for the things to be clearly improving before starting to 'dollar cost average' back in eg. if it *seems* that a bottom has been reached I might switch 10% back into growth, and then keep adding 10% each month. That way I'll probably not 'pick the bottom' but should end up doing quite well overall. Most major market corrections take at least 6-12 months to 'wash through'. And if there are 'false bottoms' I won't find myself fully invested at the early stages of a bear market.

Making a decision to get back in will be quite hard if a) market is down 25%-40% and the economy is still suffering - picking a 'bottom' can be very hard/impossible. In the Great Depression the US market declined about 90% (from ~380 to ~40) over several years, so if you'd bought back in when the market was down 80% you would then have still had to ride through a 50% decline in your investment value before the actual bottom was reached! Dollar cost averaging will help make getting back in less difficult (while I've shifted our existing SMSF investment from High Growth to Conservative/Bond Index funds, we still have a $2,000/mo investment flowing from our cash account into the High Growth fund). b) If the market turns around rapidly and is back to new highs within a few months and I'm still out -- then it will be very hard to jump back in. I'd probably start switching back in using dollar cost averaging 10%/mo. So I'd end up missing out on some performance, but would have hedged against a global economic relapse (eg. if the pandemic gets brought under control, but then the economic impacts start to flow through).

So, no definitive answer - but I won't be in a rush to reinvest in the markets, and when I do I'll probably dollar cost average in over several months.